•Behavioral—Does the company control how the worker does his job?
•Financial—Are the business aspects of the worker’s job controlled by the payer? How is the worker paid? Are expenses reimbursed and supplies given?
•Type of Relationship—Are there written contracts? Does the worker receive employee-type benefits such as vacation pay, insurance, or pension coverage?
This is not, however, a scorecard test. One cannot simply go through the checklist and tally employee answers vs. independent contractor answers. Rather, it is a relationship test, and certain factors weigh more heavily than others. In most cases, common sense usually points owners in the right direction.
For the business owner, particularly a small family business hiring an employee for the first time, the record keeping, remittance of taxes, and forms filing can be onerous. When coupled with the financial obligations of matching Social Security and Medicare taxes, as well as paying federal and state unemployment tax, the incentive to treat a worker as an independent contractor is enticing. For the worker it is certainly in his or her best interest to have taxes withheld, Social Security and Medicare matched, and to participate in any benefit programs the business may offer. Independent contractors are responsible for their own income taxes and the full amount of Social Security and Medicare taxes.
It is important to get the classification right. The penalties for misclassifying an employee as an independent contractor vary depending on whether the misclassification was willful or not. For honest mistakes, if proper paperwork was filed, the penalty is 1.5 percent of wages paid to the employee, plus 20 percent of the amount that should have been withheld for Social Security and Medicare, plus 100 percent of the employer’s share of Social Security and Medicare. These penalties can go back three years. Penalties get much worse for willful misclassification. Even by the roughest estimates, the penalty isn’t worth the risk of getting caught.
Small business owners must perform their due diligence when hiring and classifying workers. Owners who currently use independent contractors should consider reviewing the nature of their relationship with them. If workers who were classified as contractors appear to be misclassified employees, take steps to rectify the situation. There are relief measures for voluntarily reclassifying these workers. The bottom line is, don’t guess.
(A CPA or other tax advisor can help small business owners get it right. For more resources on this topic or to find a CPA in Pennsylvania by location or area of expertise, visit www.picpa.org/moneyandlife.)
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